The media has made the idea of a TWIST by the FED a sure thing. Okay, can’t argue with consensus, but of course that is why this blog exists: To question the thought process of the purveyors of conventional wisdom and to try to profit in a real-time world from challenging the status quo. If the FED TWISTS will the markets turn? BUT TURN TO WHAT? What will a lowering of the rate on the 10-year note do to a stalling economy with zero interest rates? Bernanke himself alluded to the BALANCE SHEET REPAIR taking place in the private sector, which was holding back consumer demand. Even though corporate balance sheets are healthy, capital investment lags as the corporations fear lackluster demand so there is no rush to create new supply.
The question must be asked over and over: WHAT IS THE GOAL OF THE TWIST? If its purpose is to lower the long-end of the curve, what will the outcome be? Lower mortgage rates? If the goal is lower mortgage rates, then the Treasury, with the FED‘s support, should just utilize the GSEs and mandate a massive REFI program. Bill Gross has eloquently argued that the FED’s moves on the long end is having a distortionary impact on the credit market as it is getting difficult to price corporate and other types of credit in a FED-manipulated curve. If the FED is successful in pushing 10-YEAR NOTES to 1.5%, what will the impact really be? A 3% 15-year mortgage rather than the current 3.8%? Again, just what is the FED ATTEMPTING TO AFFECT BY EMBARKING UPON A TWIST? I have discussed that those who believe they have a handle on the OPERATION TWIST outcome is “LOST IN THE OZONE AGAIN.”
The last time the FED TWISTED in 1961, Bretton Woods was in force–as well as FOREIGN EXCHANGE CONTROLS in many countries–so it was easy for the U.S. monetary authorities to direct a desired outcome. In today’s world, the ability to immediately move money all over the world could undermine any policy outcome the FED is trying to produce. If the FED is looking to push more liquidity into the financial system, and yet not disrupt the credit system as Gross fears, THEN THE FED MIGHT WANT TO JUST BEGIN PURCHASING EQUITIES. Hey, if I was Bernanke and worried about the political fallout of a QE3 program and I wanted to recreate the PORTFOLIO BALANCE CHANNEL of Jackson Hole 2010, then direct intervention into the stock market would generate the best results.
THE FED CAN OWN EQUITIES THAT AT LEAST WON’T DEPRECIATE IN A RISING INFLATION ENVIRONMENT. Remember that if the FED is successful in generating inflation through its policy of sustained low rates, then the FED BALANCE SHEET will be ladened with questionable assets. If Ambrose Evans-Pritchard was correct in his piece last week about the Chinese wishes to reallocate away from U.S. BONDS to EQUITIES, then the FED will be riding the trend rather than fighting it. Hey Ben, its your turn on the dance floor.
Quick Hitter: As the world has been focused on EUROPE and THE FED, much money has been moving from the currencies of the EMERGING ECONOMIES. In a world focused on RISK-ON, RISK-OFF, the high yielders of Mexico, Russia, Brazil and South Africa have seen large liquidations of positions. During the last QUARTER the MEXICAN PESO is down 12%; RUSSIAN RUBBLE is down 12%; and the South African RAND is off 13%. The beloved AUSSIE is even off 4.5% even though it has a robust economy and a short-term overnight lending rate of 4.75%.
In the month of September, on days when the EQUITIES stage rallies, the emerging currencies fail to rally reducing the impact of the risk-on, risk-off paradigm. Why are investors moving away from the emerging countries at this time? This is something we need to watch to judge what this movement of money is trying to convey. Throw in the recent weakness in COPPER and other industrial metals and maybe the FED knows something about a coming DEFLATION. MAYBE. BUT AS A TRADER IT CERTAINLY APPEARS THAT CHANGE IS IN THE AIR. If the DOLLAR rallies tomorrow on an aggressive FED move then we will have an indicator that a new dynamic is afoot.
Tags: 10-year Notes, balance sheet repair, Bernanke, Bill Gross, Brazil, deflation, Dollar, emerging economies, Equities, Europe, Fed, Mexico, operation twist, portfolio balance channel, QE3, Russia, South Africa, Twist, U.S. bonds